How to Choose a College Savings Plan

College student loan debt in the U.S. has risen to over $1.3 Trillion in 2017 affecting nearly 70% of all graduates. As the student loan debt crisis in America continues, choosing a college savings plan for your children increases in importance. With several different college savings plans available, however, you may find it difficult to decide which college savings plan is correct for you. Among the most common college savings plans that parents can invest in are the 529 plan, the Coverdell education savings account, and the custodial account. All these savings vehicles have their pros and cons, and which one you choose depends primarily on your goals.

529 Plan Explained

Out of all the college savings plans out there, the 529 plan is most certainly the most well recognized, however, many people don’t know how they actually work. The 529 plan is a tax-advantaged savings plan that is designed to encourage saving for future college costs. While all states in the U.S. recognize at least one type of 529 plan, they actually come in two different types: prepaid tuition plans and college savings plans. A prepaid tuition plan is relatively close to what it sounds like, the saver or account holder is allowed to purchase tuition credits at their current rates. The money can’t be used to pay for things like room and board though. It’s important to note that prepaid tuition plans aren’t guaranteed and if the beneficiary doesn’t attend a participating university the money may pay less. This plan is a good choice for a beneficiary who chooses an institution that isn’t in danger of a financial shortfall and where they meet the participating university’s residency requirements.

The second type of 529 plan is the college savings plan and it allows the college saver to open an investment account to save for tuition, as well as, fees, and room and board. These plans are sponsored by governments and only a few have residency requirements which allows the money to be used at more universities and colleges. These savings plans are typically based on mutual funds and ETF’s and thus may not be ensured by the FDIC which could mean your investment could decrease instead of increase.

Anyone can set up a 529 plan which allows your money to grow tax-free as long as it is withdrawn for qualifying educational expenses. Because of this, a 529 plan can be a valuable gift and estate tax planning tool. 529 plans are generally a great all-around college savings plan as they have a low impact on other types of financial aid.

Coverdell Education Savings Account

When considering alternatives to the 529 plan, the Coverdell education savings account works in a similar manner. They both allow the primary funder of the account to remain in control of the money and both offer tax-alsodeferred savings. Where the two differ, however, is that the Coverdell education savings accounts are phased out for incomes between $95k and 110k (single filers) or $190k and $220k (joint filers). Additionally, you can only contribute $2000 per year up until the beneficiary turns 18, making it a less effective tax shelter. The primary benefit of a Coverdell ESA is that the definition of qualified expense includes primary and secondary school, not just colleges and universities. Also, the balance of a Coverdell account must be disbursed before the beneficiary reaches the age of 30 in order to avoid tax penalties.

Custodial Account

Also known as a UTMA or UGMA account, a custodial account places money in the name of the beneficiary with whoever established the account acts as the custodian. In many ways, these accounts are similar to trust funds with the custodian having fiduciary obligations to the beneficiary. The income earned in a custodial account is taxable to the beneficiary at their specific tax rates. The main benefit of a custodial account over a 529 plan is the flexibilt8y as they allow the custodian to invest in their own stocks, bonds, and/or mutual funds. Furthermore, the money can be spent on anything that will benefit the child, not just educational related expenses. As a drawback, the money is listed on the child’s assets so it can hurt when applying for financial aid.